James Adkins | Europe and Eurasia Fellow
German Chancellor Olaf Scholz. Image sourced from the European Parliament via Wikimedia Commons.
Within the space of just half a decade, Germany has gone from being hailed as Europe’s leading economic power to being branded ‘The Sick Man of Europe’, beset by chronic low growth and plummeting competitiveness. To overcome its geoeconomic challenges and strengthen its economic resiliency, Germany must reduce its external dependencies and redefine its approach to investment, debt, trade and security.
In the early 2010s, while much of Southern Europe suffered during the Eurozone crisis, the ‘German Economic Model’ was lauded as an exemplar for others. Yet a decade later, Germany’s fortunes could not have shifted more dramatically, with what were once seen as its economic assets – budgetary discipline and large trade surpluses – now viewed as vulnerabilities. While Spain, Italy, and Portugal have recorded strong post-COVID recoveries, the IMF forecast Germany’s economy to shrink for the second year in a row in 2024 – rendering it the weakest in the G7.
The primary cause of Germany’s current economic stagnation was its heavy dependency on Russian energy. After Russia’s invasion of Ukraine in 2022, the German economy was hit hard by surging energy prices which detrimentally impacted its powerhouse industrial sector. While Germany has now succeeded in weaning itself off Russian gas, businesses both large and small are loath to invest while energy costs remain elevated. Industrial giants such as BASF have permanently downsized operations and shifted plants to China due to the uncertainty.
To restore its energy security and regain competitiveness, Germany must significantly step up investment in renewable energy. However, these efforts have been constrained by its stubborn attachment to the ‘debt-brake’ – a constitutional provision which places significant limits on borrowing. For instance, in 2023, €60 billion allocated to the green transition was ruled unconstitutional by Germany’s highest court. The German government should loosen – if not remove entirely – the arbitrary spending limits imposed by the debt brake to unlock badly needed investment.
In addition to the Russian energy shock, Germany now faces a major trade shock from China. Unlike other major economies such as the United States (US), German industry was initially a major beneficiary of China’s entry into the World Trade Organisation in 2001. For two decades, German automakers profited enormously from exports to China. However this dynamic has since flipped, with the rapid growth of electric vehicles (EVs) destabilising German car giants such as Volkswagen. The German car industry now faces an existential threat as the European market is flooded with millions of cheap EVs from Chinese manufacturers like BYD.
Although the competitive advantage enjoyed by Chinese EV manufacturers was unfairly obtained through massive state subsidies, Germany has failed to acknowledge these market distortions for fear of damaging its exports to China. When the EU recently proposed placing tariffs on Chinese EVs, Germany was one of a handful of countries to oppose the move. Despite releasing its first ever China strategy last year, such actions exemplify Germany’s ongoing naivety towards China. To protect its industry from the threat posed by China’s overcapacity in green technology, Germany must back the EU’s approach to ‘de-risking’ its relationship with China.
Nevertheless, German and European economic challenges run far deeper than just energy or trade. In an age when semiconductor chips are as vital as mechanical engineering prowess, Germany and the EU risk being left behind the US and China in the technological revolution. Before the 2008 global financial crisis, the EU’s total GDP was slightly higher than the US. Yet by 2023, the EU economy had fallen far behind to be half the size of America’s. A large driver of this divergence is Europe’s lack of a strong technology sector and expertise in emerging fields like artificial intelligence. While the EU might excel at tech regulation, it lags significantly on innovation.
Consequently, some EU policymakers fear that Europe risks becoming an ‘open-air museum’ while China and America surge ahead in the technologies of the future. A highly anticipated report into European competitiveness by former European Central Bank governor Mario Draghi has highlighted the massive public investment required to spur innovation and growth. Draghi recommends creating common EU debt – something Germany has long resisted. Given the urgency of the EU’s economic situation, Germany must overcome these misgivings – as it did when it agreed to the ‘NextGenerationEU’ recovery fund at the height of the pandemic.
While the challenges posed by Russia and China are unsurprising, Germany’s next shock may come from its most important non-EU ally – the US. Should Donald Trump win a second term, the transatlantic economic and security relationship may be deeply jeopardised. In addition to routinely slamming the EU, Trump has fixated on hammering the German car industry. While the EU has setup a ‘Trump task force' to prepare retaliation against US tariffs, Germany may be hesitant to support such moves, fearing the withdrawal of American military infrastructure from Europe – including recently deployed long-range missiles. Such risks compound the urgency of Germany reducing its security dependency on the US and delivering on the promise of the ‘Zeitenwende’.
Germany’s export-driven economy prospered during the era of peak globalisation and world trade from the 2000s to the mid-2010s. However, with the return of great power competition and geopolitical fragmentation in the 2020s, Germany’s deep dependencies on Russia, China and the US have left it badly exposed to external shocks. Germany desperately needs to adapt to this new reality by redefining its approach to investment, debt, trade and security to build geoeconomic resilience.
James Adkins is the Europe and Eurasia Fellow for Young Australians in International Affairs. He recently completed a Bachelor of Arts and Bachelor of Modern Languages majoring in Political Science and International Relations, French Studies, and German Studies at the University of Western Australia.
During his fellowship, James looks forward to exploring contemporary geopolitical developments shaping Europe and the wider Eurasian region, including their implications for Australia and our region, the Indo-Pacific.
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